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It’s been a busy time in the OTT market with players coming and going and the choices available to customers growing more complicated and confusing. Here are some of the bigger recent events in the industry.

Continued Cord Cutting. The major cable providers lost 946,000 cable customers in the second quarter – the worst quarterly loss ever. This puts cord cutting at an annual loss rate of 2.7% of customer, up from only 1% a year ago. It’s obvious that cord cutting is picking up momentum, and the wide variety of OTT viewing has to be a contributor. Nielsen recently reported that 62% of homes now watch OTT content at least occasionally.

It’s getting harder for analysts to count cable customers. For example, Dish Networks is not reporting on the specific performance of its satellite service versus SlingTV. The losses for the quarter were also eased a bit by the fact that Charter began counting seasonal customers even when they go dormant, such as the snowbird in Florida who subscribe only in the winter but who keep the account active.

ESPN / Disney OTT Offering. Disney announced that it would be launching two new OTT offerings in 2019 – a standalone ESPN offering and a standalone Disney offering. Along with this announcement they announced they will be withdrawing Disney content from Netflix. The ESPN offering will not duplicate the cable version of the network and will not include things like the NFL and NBA. But it will include major league baseball, the NHL, major league soccer, grand slam tennis events and college sports. Analysts think this offering is mandatory since ESPN has lost 13 million subscribers since 2011 and advertising revenues dropped 8% last quarter.

The standalone Disney offering is also interesting in that the company has decided to take Netflix on head-to-head. Because of contractual arrangements Netflix will still have access to content produced by Disney such as the numerous shows produced by Disney’s Marvel Studios. But starting in 2019 Disney is going to make new content only available on their own platform. This prompted Netflix to purchase Millarworld, a major comics producer.

NBC Closing Seeso. NBCUniversal says that it will be ending the Seeso OTT offering later this year. This is an offering that consisted largely of NBC comedy and related entertainment such as Saturday Night Live and the Tonight with Jimmy Fallon.

This failure is a big warning to the many cable networks that have been contemplating using the strategy of shoving existing content online. Industry analysts say that simply taking linear content online is not a recipe for success. It seems that the platform is just as important as the concept and the bigger platforms like Netflix keep customers engaged and enabling them to move from show to show without leaving the platform. But it’s too easy for a customer to leave a limited-offering platform, thus diminishing the perceived value for customers to buy a subscription.

Facebook OTT Offering. Facebook has announced the launch of Watch, an OTT service that will include content from A&E, Univision, Major League Baseball and other content such as worldwide soccer. For now the new service is being launched overseas with some limited US trials, but is expected to hit the whole US market later this year.

The offering is being structured like YouTube to enable content creators to launch their own channels. Facebook is currently funding some content providers to seed content on the new service. They are hoping that within time the platform becomes self-sustaining and can be an alternative to the wildly popular YouTube. Facebook is counting on their ability to lure enough of their billion plus users to the new platform to make it a success. The company’s goal is to keep people on their platform for more than just social networking.

Apple. Apple will be entering the OTT world and announced that they will spend $1 billion to create programming content over the next year. This puts them into rarified company with Netflix that is spending $6 billion, Amazon at $4.5 billion and HBO at $2 billion. There is no news yet of the nature or timing of an Apple OTT offering.

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Seal of the United States Court of Appeals for the Second Circuit. (Photo credit: Wikipedia)

As often happens with many controversial topics in our society, the fates of Aereo and its clone FilmOn X are now in the courts. These companies supply antenna receivers to customers and let them receive live, local, over-the-air television from the local network affiliates of ABC, CBS, FOX and NBC on internet connected devices including TVs, tablets and smartphones. These companies are claiming that since the signal goes directly on a single antenna to only one customer that they don’t have any obligation to pay retransmission fees to the network affiliates for the programming.

Of course the large networks disagree vehemently with that interpretation and have sued the two companies. In April, Aereo won a suit in New York, which was then upheld later in July in the Second Circuit Court. The judge who ruled in the Aereo suit concentrated on the way that Aereo transmits the signal rather than rule on the issue of copyright infringement that was brought by the networks.

The networks also sued FilmOn X using the same arguments that they had used against Aereo. FilmOn X is an odd company in some ways because in the past it went by the names of Aereokiller and BarryDriller.com, both names that are a dig at Barry Diller, the founder of Aereo. In fact, there are conspiracy theories flying around the Internet that FilmOn X was secretly founded by the networks for the purposes of being sued and losing on the Aereo issue.

A week ago the District Court of Washington DC ruled against FilmOn X saying that the company had violated the copyrights of the networks. A week later the same court refused to accept an appeal on the issue. The suit puts an injunction on FilmOn X from operating.

So now there are two district courts with differing opinions on the same topic. The two courts heard essentially the same arguments and came to different conclusions. Generally the only way to resolve this kind of dichotomy is for the Supreme Court to hear the case and to resolve the issue.

But until then both companies are in legal limbo. Aereo came out this week and publicly advised FilmOn X to ignore the injunction. Aereo also made an effort to distinguish that its technology is different than that of FilmOn X, but the differences are subtle. Aereo continues to expand to new markets and continues to face additional lawsuits in each new market it enters.

As somebody on the sideline I really don’t know how I hope this case resolves. Part of me says that this suit is a result of the greed of the networks which are now pushing to get as much as $2 per month per subscriber in retransmission fees for each local channel. Everybody in the industry understands that we are starting to price cable TV service out of the range of a lot of households, and yet the networks and every other programmer keep pushing for higher and higher fees. As a whole the industry is laying the foundation of its own decline, and if the fees weren’t this high, then Aereo wouldn’t have a business plan.

But the other side of me says that the networks are right, at least under the current cable rules at the FCC. Of course, those rules were made in a very different time a few decades ago when nobody contemplated the ability for somebody to bypass the cable companies as Aereo has done. Certainly the FCC ought to take another look at cable regulations and update them to account for the realities of TV over the Internet.

But from what I understand, nothing is likely to happen since Washington is in gridlock. The FCC is not free to change the rules too much without authority from Congress, and there does not seem to be any impetus for Congress to look at the cable rules. So, like often happens when policy makers don’t make policy, it’s all up to the courts.

ESPN, Fox Sports, Comcast SportsNet, and regional sports networks like the Big Ten Network must all be lobbying hard against a la carte cable programming ever becoming a reality. Their business model relies on the practice where all cable subscribers must pay for sports even if they never watch it. Sports programming has become a significant chunk of what customers pay each month for cable TV and the rates charged for sports networks are growing at the fastest pace.

It’s not hard to see why sports programming is so expensive because the sports networks pay a lot of money to obtain exclusive sports content. Let’s look at ESPN as an example. It was reported in financial news that ESPN will pay over $3.5 billion in 2013 for sports programming. That includes $1.1 billion to the NFL, $600 million to the NBA, $610 million for football bowl games, $360 million to major league baseball, $240 million for ACC sports, and many other smaller deals.

And the amounts that are being paid keep rising. It’s been reported that in 2014 the fee for the NFL will jump to $1.9 billion and for baseball to $700 million. The network just announced an eleven year deal for $770 million to broadcast the U.S. Open Tennis Tournament. And ESPN will be launching a new network for Southwest Conference Football in 2014 and the details of the amounts to be paid have not been announced, but one has to imagine they are huge.

How much does this all cost consumers? Not all cable companies pay the same amounts for ESPN since there are individual contracts with each cable company that span different periods of times. I’ve seen recent articles that say that the average monthly cost charged today for cable companies for ESPN is $5.13 per household, with additional monthly fees of $0.68 for ESPN2, $0.18 for ESPNNEWS and $0.18 for ESPNU. For 2013 those fees total to over $7.3 billion. A household getting all four of these channels would be paying $74 per year just to ESPN. And if they have a cable provider that carries all four of those channels there is a good chance they are also paying for other sports networks like FoxSports, Comcast SportsNet, the NFL channel, the golf channel, the Tennis channel and a bunch of others. And the fees paid for sports aren’t even always obvious since there is a substantial fee for the Olympics buried in the fees for carrying the NBC channels. It’s probably not a bad guess to think that the average cable household is already paying over $100 per year today for sports coverage.

And the fees are continuing to climb at a rate far faster than inflation. It’s been reported that a recent deal signed by Time Warner Cable has them paying almost $7.50 for ESPN by 2018 with a built-in annual 6.5% rate increase after that. This would put the cost of ESPN over $8 per household per month by the end of the decade, or almost $100 per year.

As I have written in the past, the whole cable industry is starting to see subscribership fray around the edges. It was just reported by Variety last week that all cable companies combined lost about 80,000 customers for the 12 months ending March 31, 2013. That doesn’t sound like a lot, but just a few years ago cable subscribers were growing by several million per year. Industry experts predict the number of cable subscribers will begin dropping more each year, much like what happened with landline telephones over the last decade. There are a lot of reasons for this including cord cutters who are dropping cable for programming on the web, and young households who just aren’t signing up for cable. But one contributing reason is rate fatigue, meaning that households are finding the rates for cable to be more than they are willing to pay.

So why would the sports programmers be sweating a change to a la carte programming? It sounds like a really good idea for customers to be able to buy just the programming they want. What sports lover would not love to ditch Lifetime Movies, and what sports hating household would not want to stop paying for ESPN?

The answer is simple math. If a la carte programming is introduced then buying what you want will be too expensive. Let’s just look at ESPN as an example. Let’s say ESPN went to a la carte programming so that only households who wanted it would buy it. The amount that ESPN would charge on a standalone basis would depend upon how many households they think would be willing to write a check for ESPN. Let’s look at the math. This assumes that the cable company would mark-up the channel by 30%. These are the resulting monthly subscription rates:

Willing To BuyRate TodayRate in 2020

50% $15 $20

30% $26 $33

15% $51 $67

This table must scare the hell out of ESPN. We already know what a la carte looks like. HBO is sold a la carte and is in 30 million homes, or 30% of the US market for around $15. I look at this table and find it hard to think that 30% of homes would pay $26 monthly for just the four ESPN channels. There is probably no price point on this table that looks realistic in the market, and so the reality is that if ESPN was to be sold on an a la carte basis that they would have to cut their rates, meaning that they would have to cut the payments they are making to the various sports. And that would have a profound impact on the sports industry. For example, universities in the major conferences now rely on cable revenues to support their teams and one can imagine massive cutbacks in college sports if the TV revenues decline. Television fees are the main factor behind the huge salaries paid by professional sports.

And this same math is going to be the same for every other sports network – and as far as that goes, for every cable network. If a la carte programming comes to pass and people buy only what they want, they are going to end up paying as much as they do today for a smaller number of channels. Today’s regime of averaging the cost of hundreds of networks across 100 million cable subscribers has resulted in the wide variety of programming available to a cable household. It is my prediction that under a la carte programming that many of the networks we watch today would fold because they could not find enough buyers individually to support them. And maybe that is what should happen. Certainly, if the cable industry starts seeing total subscribers dropping by millions per year this will happen eventually anyway. There just won’t be enough money to support all of the networks. I can’t see any future where the amount of monies paid by ESPN and other sports networks to obtain programming rights doesn’t go down. It’s just a matter of math and time.

It makes it voluntary for cable operators to offer a la carte programming.

It mandates broadcast networks (ABC, CBS, NBC, FOX, etc) offer their channels to cable providers on an a la carte or face the possible loss of their broadcast license.

Programmers like Discovery and Disney can only sell their programs as a bundle if they also offer them a la carte. So cable operators can buy only the programming that they want.

It threatens that any broadcast network that pulls its programming off the airwaves would lose the spectrum and also any rights that go with being a broadcaster. This is a threat for local networks to not mimic Aereo.

Current sports blackout rules won’t apply in cases where the stadium being used was publicly financed.

Here are the practical consequences if this bill becomes law:

Cable companies could save money by eliminating channels they don’t want to buy. I helped one client get into the cable business a few years ago who ended up taking almost twenty more channels than they wanted due the bundling requirements from the programmers. And so I see cable providers shedding channels. This may not necessarily result in any price cuts and might just increase the profits of the cable company. But over time this ought to help hold down costs and rates.

This bill does not mean that any customer will get a la carte programming. In McCain’s announcement he said that ESPN costs $4.69 per month. That is the price that a cable provider pays for the ESPN suite of channels if they agree to make them available to, and charge every customer for them. But if ESPN is forced to sell this on an a la carte basis, they understand that a lot of households are going to opt out of paying for it since many households have no interest in sports. I would expect that ESPN’s a la carte price is going to be a lot higher than the $4.69 bundled price. If that occurs (and there is nothing in this law that would prohibit it) then the math for ESPN and customers changes drastically overnight. Rather than everybody paying $4.69, if only one-third of households would want ESPN the price would have to go to nearly $15. And this same kind of math is true for every cable network. So my prediction is that none of the large cable companies will move their programming to a la carte. But there might be small ones who try it.

This benefits companies who want to deliver programming in a non-traditional way. This might open the door for Aereo or web-based companies to buy programming. I can see sports fans willing to pay $30 a month for a suite of sports channels and nothing else. But the first cable company that tries this is going to see the wheels come off. It could end up costing consumers as much to buy the channels they want a la carte as it is to buy the big bundles of today, due to the way the current pricing averages the cost across millions of homes instead of just those who want to watch it.

I can see cable operators who will put the broadcast networks on a la carte. There is a huge battle between local stations and cable companies over retransmission fees and I can envision cable companies who will price each channel according to what they must pay and letting the public deciding what they want to watch.

Marginal cable networks will fold. Some of the large programmers have made cable providers buy channels they didn’t want, and if enough of them elect to shed some of these networks they will fold.

It would be interesting to know if this law would override existing multi-year contracts for programming or if it would force new contracts immediately.

The primary benefit of this law is that it breaks the bundling being done by the large programmers who own many channels. The cable business is not profitable for cable operators and I have some clients who lose money on cable. They make almost all of their profits on data and voice. If cable companies have the ability to set any line-up they want they might be able to return some sanity to what they pay for programming. Over time this might be the change that breaks some of the power of the programmers and stops the insane price increases. McCain cites a 6.1% average increase in programming costs since 1995, but where I have been tracking it in the 2000’s it has been more than 7%. These kinds of rate increases are heading the whole industry towards a consumer revolt. If the 6.1% increase that McCain cited continues unabated, a $75 cable bill today would be over $136 within ten years.

The real shame of the bill is that the public will interpret this bill to mean they are going to get to pick just the channels they want to watch and that is still unlikely to happen. The bill is a good idea, but it’s really a la carte for the cable companies, not a la carte for consumers.

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There are a number of trends affecting the cable TV industry that all add up to an industry that is going to be seeing big changes over the next decade. These are what I see as the biggest trends affecting the industry:

Cord Cutters. The number of people who are completely dropping cable is growing and the speed of that drop is accelerating. I have seen several different recent estimate that 5 million households will have completely dropped all cable service by the end of 2013. And only the cable providers know how many other million households that have cut back on the size of the package they buy rather than drop service totally. I anecdotally know many people, myself included, who have gone from the big cable packages to something less – in my case I now have only the basic package of about 20 channels.

Higher Programming Costs. Programming costs have been rising steadily for the last decade and until the last few years were climbing between 6% and 7% per year. Costs have climbed even faster in recent years due to the high fees being demanded by local network channels in each market (ABC, NBC, CBS and Fox). Local network programming was free for cable companies until a few years ago, but now they paying as much as $1 per month per customer for each major network channel. Many contracts between cable providers and programmers are for multiple years and those contracts show the price increases are going to continue to come.

Even Higher Rate Increases. The large cable companies have increased rates around 7% per year for many years. The programmers have usually blamed the size of the increases on increased programming costs, but until the recent increases in local network programming the increases were generally about twice what was needed to cover programming cost increases. If the rate increases continue at that level, then a $70 package today will cost $129 in ten years. Prices are already at a point that are forcing households off the network.

Very Solid Cable Modem Business. To a large degree the cable companies have won the war with DSL. However, they have stiff competition from Verizon and FiOS on fiber. There is limited competition outside the Verizon footprint, but with Google building fiber in Kansas City and having announced Austin and Provo there is going to be more competition for the residential business.

What do these trends add up to? I see them resulting in the following:

Ever decreasing cable customer base. The most dire trend for the industry is that young people are not interested in traditional cable, and as that demographic ages the percentage of households wanting cable is going to drop faster and faster. Add to this the households dropping due to never-ending price increases and most experts see cable subscribership going down the same path as landline telephones. Subscribers are dropping somewhat slowly now, but every prediction I have seen believes the rate of disconnects will accelerate over time.

Cable Providers Become Data Companies. As cable penetration decreases the cable companies will become more and more reliant on selling data. This is going to lead them over time to maximize their networks for providing bandwidth for data rather than cable TV. And I predict it also means that they will start raising data prices over time, something that we just started seeing in the last year. There is not much profit in selling cable packages and the cable companies could be more profitable selling data eventually (assuming they are in markets where they don’t have stiff competition).

Winnowing of Cable Networks. As the industry loses subscribers and as people downgrade from larger packages to smaller ones, the demand for some of the networks is going to diminish. One way for cable companies to control costs is going to be to whittle away at their line-up, and that is not that hard to do with 300+ channels on many cable systems. So some of the marginal networks are going to either die or greatly reduce the fees they charge if they want to stay in business.

There is one change that might affect the industry that could upset these trends, and that is a la carte programming. There are a lot of barriers to make that happen, but cable companies might get new life if they are able to sell only those channels that people want to watch. It’s certainly possible that they could sell a package of 20 channels to a family at an affordable price and make more profit than they do today with the large expensive packages. But this is going to require a major change in an industry that is currently controlled by the programmers and not by the cable companies.